November 2002
By ROBERT PEGG
Recent revisions in the gross domestic product show that the nation's economy was in a recession well before the Sept. 11 terrorist attacks and shortly after the stock market began to weaken. Since that time, the nation's economy has proven remarkably resilient, confounding the critics. With an economic recovery now in place, albiet a weak one, history will show that the recent recession was among the mildest in recent memory. Despite the turmoil in the Middle East and the continuing uncertainty in the financial markets, Americans still are willing to open their wallets and spend.
Perhaps some of that reason is that many consumers still have relatively limited exposure to the bear market. Only about half of Americans are invested in the stock market, even with the dramatic growth of 401(k) and pension plans, although the proportion of those people owning stocks has increased significantly over the last two decades. On the other hand, almost 68 percent of Americans are homeowners. Soaring demand for housing and increasing home prices in many metropolitan areas of the U.S. over the past few years has carried more weight for most consumers than the lower equity prices. With falling mortgage rates stimulating surges in refinancing, American consumers have gained more than $50 billion in wealth in the first half of 2002 alone. Low interest rates and rising home values have encouraged consumers to hold more home-equity debt. Although increased long-term debt may pose a problem, if the economy unexpectedly takes a downturn, the low cost of borrowing today has been a bulwark against the weaker stock market and has stabilized the domestic economy.
Another factor in helping the economy has been improved productivity. Healthy productivity gains have translated into steady income growth for many Americans. Solid growth in salary and wages suggests that consumers do not have to spend beyond their means. In addition, a stabilizing job market will further help support consumer sentiment and spending. Toward the end of 2002, corporate layoffs were below their recession peak and job declines in many areas of the nation appeared to be easing.
Finally, price inflation has been muted. Overall, consumer inflation has been the lowest in decades, despite recent higher oil prices. Retail and food service prices, excluding automobiles, fell 2.3 percent in 2001 and the auto industry's re-enacted zero percent financing has prompted a new wave of vehicle purchases. Vehicle sales have risen strongly, and its strength suggests that consumers are willing to buy big-ticket items, even if their stock portfolios are lower.
Nonetheless, the future of the economy, as always, rests on the shoulders of American consumers. If they eventually stumble because of the lower stock market, a lack of confidence in corporate accounting, or another terrorist attack, the economy could stumble as well.
The latest data and thinking by most economists suggests that the economy will continue to recover and expand, although the pace will be slow. One negative factor is that banks have become more cautious in their lending policies and credit markets have been tightening. As a result, the business sector remains extremely vulnerable. Tightening credit conditions have increased the cost of capital, making it more expensive for companies to invest in plants and equipment. At the same time credit-rating agencies such as Moody's and Standard & Poor's are downgrading the debt of many of their corporate clients, making it harder for those clients to obtain the funds needed to invest.
Still, business investment can't be put off indefinitely. Companies must replace old equipment and aging technology to stay competitive. On the bright side, spending for equipment and software has been rising and corporate profits have been positive in 2002. Companies may attempt to sit tight and spend just enough to stay healthy and competitive. While this strategy may portend a weak recovery into next year, most economists forecast a gradually improving economic picture in 2003 and 2004.
About the author: Mr. Pegg is president of Kirkbride Asset Management, the New York City-based investment advisory firm which serves businesses, institutions and private individuals.